Question

Money and monetary policy. In December, Janet Yellen announced that the Fed would start raising interest rates from their long term level of just above zero. Why would she do such a thing? Doesn;t she know that raising interest rated will slow the economy down and that no one wants unemployment to rise? Can you defend Janet Yellen? How about Ben Bernake or Alan Greenspan? Who are these people and why are they important?

Answer 1

The Fed conducts the nation's monetary policy under a mandate from Congress to promote maximum employment, stable prices and moderate long-term interest rates in the U.S economy

The Fed began its current round of rate hike in 2015 and funds target rate at 1.25% from 0% three years back. The Federal open market committee judges that inflation at the rate of 2% is most consistent over the longer run with the Fed's mandate.

Since the Fed began the rate tightening cycle, inflation had fallen from 2% to 1.3%. If we consider a policy lag of 6 to 9 months for Fed hikes to feed their way into the broader economy, it would appear that ear;y hike in2016 have had their desired impact on inflation and with the tick up, in the unemployment rate one would think Fed would stop hiking now.

The simple reason was that Janet Yellen was hawkish by nature. She took the helm of the Fed in February 2014. The fed would have halted its tightening cycle given increased negative sentiment of its communications with the recent drop in inflation and modest unemployment rate. But Yellen effect was keeping the hikes on.